Next report will be on may 25th
Markets: Fixed Income
On Tuesday, government bonds declined further, as investors remained optimistic on an economic recovery despite a mixed set of data. In the euro zone, the ZEW index rose for the seventh consecutive month to a 3-year high. But in the US, the housing starts fell to a new record low suggesting that it is too soon to see a rebound in residential housing construction. Investors however ignored the weak housing starts, as US equities recouped the opening losses and soon trended again higher. A late selling wave however reversed the gains and the S&P closed slightly lower, which was no bad performance, taking into account Monday’s gains of more than 3%. The increasingly confident view from investors on an economic recovery was also reflected in the VIX index, which fell below the 30 level for the first time since September last year.
In a daily perspective, the US yield curve steepened further, as 10- and 30-year yields rose by around 1 basis point, while 2-year yields fell by 2.5 basis points.
In the euro zone, German yields rose more sharply, as they still had to catch up part of Monday’s increase in US yields and ahead of today’s massive supply from Germany and France. The belly of the curve was hit the hardest, as 5-year yields rose by almost 10 basis points compared to 7.1 basis points in 2-year yields, 8 basis points in 10-year yields and 5.6 basis points in 30-year yields. As a result, 10- year yields rose again above the key 3.40% level and 30-year yields closed at their highest level since last November at 4.26%. The improvement in risk appetite was also reflected in a further narrowing of the intra-EMU sovereign spreads.
Massive supply from Germany and France today
Today, the calendar is thin both in the euro zone and in the US as it only contains the Italian industrial orders and US weekly mortgage applications. Italian industrial orders are forecasted to extend their decline, dropping by 2.5% M/M in March, but the pace of contraction slowed somewhat recently.
On the supply front, both Germany and France will tap the market. Germany will issue a new 10-year benchmark 3.5% July 2019 for an amount of €7B. At the issuance of the previous benchmark in November last year, total bids failed to meet the total amount on offer, which obliged the Bundesbank to retain more than €2B for its own operations. Also at the two following auctions, the bids fell short of the amount on offer. Only at the last auction in March, demand was decent. The problems to sell the German Bund highlight the difficulties governments face to fund their record deficits, especially at longer-term maturities. Today, France will also issue a new 2-year benchmark 1.5% September 2011 and tap its 5-year benchmark 2.5% January 2014 for a total amount of €6.5-8B as well as two longer-term linkers for an additional amount of €1-1.5B. The French auctions should pose less of a problem, as the expectations for a prolonged period of low policy rates supports demand for shortterm bonds, while the upside inflation risk is hedged with the linkers. Yesterday, Ireland successfully sold €1B of which 0.7B allocated in the 4.4% 2019 and 0.3B in the 4% 2014.
On the ECB front, the ECB will hold its monthly non-monetary policy meeting. Yesterday, Slovenian council member Kranjec denied that there was any disagreement within the ECB governing council, as he said that the ECB has ‘a unified stance on the next policy moves’ and added that his comments of last week were taken ‘out of context’. According to Bloomberg, Kranjec said at that time ‘we don’t exclude the purchase of first-class corporate bonds, short-term securities such as commercial paper’ and asked whether the ECB will spend more than 60 billion euros, Kranjec said: ‘Very likely’, adding ‘this is not the final amount.’ The comments contrasted sharply with those of German Bundesbank president Weber, who insisted that €60B would be the maximum. Today, the ECB may further discuss the details of its covered bond plan, but it’s unlikely we will get more information before the next policy meeting on the fourth of June.
Regarding trading, this week’s trading action indicates that the underlying sentiment is still quite upbeat, as equities and commodities reversed part of last week’s losses and remain close to key resistance levels at 943 in the S&P500. A sustained break higher could also have major implications for the European bond market, where German 10-year yields are again testing the upside of its sideways trading range at 3.40%. Therefore, a sustained break higher in the equity markets is likely to go hand in hand with a break higher in longer-term yields. In the US, 10- and 30-year yields are still above the necklines of their multiple bottom formation seen at respectively 3.05% and 3.85%. As such, yesterday’s trading action puts our sideways trading range between 2.90/3% and 3.4% in German 10-year yields under severe strain, but we don’t front-run on a break higher.
In the UK, the calendar contains the CBI industrial trends survey and the Bank of England minutes. In the previous months, the CBI industrial trends survey showed some signs of stabilization in total orders although at very low levels. Also in April, the expectations for the next three months improved and therefore also the headline index might rise somewhat this month. The minutes of the FOMC meeting on the 7th of May might be somewhat outdated after the publication of the quarterly inflation report. It will nevertheless be interesting to take a close look at the rationale behind the increase of the asset purchase program from £75B to 125B.
